Strategic Management: Formulation and Implementation

Learning Curves

It is when the product life cycle is put together with
the learning curve that inferences are drawn which have
major strategic implications.

The learning curve (also know as an experience curve)
can often play role is determining a firm's long-run
success of failure and therefore also lays an important
role in competitive strategy.

The learning curve was adapted from the historical
observation that individuals performing repetitive tasks
exhibit an improvement in performance as the task is
repeated a number times.

Empirical studies of the phenomenon yielded three
conclusions on which the current theory and practice is
based:

* The time required to perform a task reduce as the
task is repeated. Put another way, business
organizations, like individuals, learn from
repetition and this learning works to make
production more efficient (Hayes and Wheelwright
1984)

* The amount of improvement decreases as more units
are produced.

* The rate of improvements has sufficient consistency
to allow its use as a prediction tool.

The learning curve phenomena affects average cost in
a way similar to that for any technological advance that
improves productivity efficiency. Both involve a
downward shift in the long-run average cost curve at all
levels output.

That is, learning through production
experience permits the firm to produce output more
efficiently at each and every output level. Increased
labor, management, and material productivity are
associated with learning-curve effects.

The experience curve shows that the cost of doing a
repetitive task decreases by a fixed percentage each time
the total accumulated volume of production (in units)
doubles (Figure 4-3). For example, the total cost might
drop from 100 when the total production was 10 units, to
80 (= 100 x 0.80) when it increased to 20 units, and to
64 (= 80 x 0.88) when it reached 40 units. In the
horizontal axis is the accumulated volume of production
(in units), and in the vertical axis we have the deflated
direct cost per unit (the actual cost corrected for
inflation). Every time the accumulated volume of
production doubles, the cost per unit decreases to 80%
of the previous level.

This relationship between the accumulated volume of
production and the deflated direct cost can be expressed
in a log-log graph as a straight line, which is easier
to work with.

The accumulated volume of production represents the
total number of units delivered since the very beginning
of the production activity, and it should not be confused
with the production rate, which corresponds to the number
of units delivered in a stated period.

The cost predicted by the experience curve effect can
be obtained from a simple negative exponential
relationship of the following type:

where:
In the 80% curve, the constant 'a' can be obtained by
recognized that doubling the production reduces the cost
to 80% of its initial value. This corresponds to
introducing the values.in the expression:
The resulting solution is a = 0.322

Other values of this constant for different slopes of
the experience curve can be figure. For
example, the manufacturing of integrated circuits
approaches a 70% slope, air conditioners show a 80%
slope, and primarily magnesium exhibits 90% slope, cement
manufacturing 70% slope, power tools 80%, and industrial
truck 90% slope.

The actual significance of the experience effects for
a given industry depends not only on its inherent slope,
but also on the speed at which experience accumulates,
measured by the rate of growth in the market.

The potential for cost reduction is greatest in
industries with string experience effects and fast
growing markets, like the semi-conductor and computer
industries in recent years.

The experience curve provides important insights for
strategic planning, particularly of pricing decisions.
There are at least two different pricing strategies based
on the experience curve:

* A firm can follow a short-run profit pricing
strategy, in which the firm reaps large profits by
keeping its prices high while its marginal cost of
production declines with increased volume.

This is shown as Period A in the left of Figure
4-6. If led too long, such a strategy encourages
competitors to enter the market, which may result
in a steep price decline or a competitive shakeout.

This is shown as Period B in the left part of Figure
4-6. As a result of the competition, profit margins
remain thin in Period C.

* The firm may follow a barrier pricing strategy in
which it aggressively lowers prices as its costs
decline with increased cumulative volume. Such
lowered prices act as a barrier to market entry and
keep the firm's market share high- another strategic
implications.

Although firm's profits margin may be
modest, but long-term profits tend be to relatively
stable. Such a pricing strategy is shown in the
right half of Figure 4-6.

The most important factors for a systematic decrease
in cost with accumulated volume are:

* Learning. In repeating a task over and over, a
person develops skills allow him to do the work
more efficiently.

* Specialization and Redesign of Labor Tasks. The
increased volume leads to a division of labor that
allows for specialization and standardization both
contributing to improved productivity.

* Product and Process Improvements. As volume
increases, many opportunities open up to improve the
product and process and thereby achieve higher
productivity and cost reductions.

* Methods and Systems Rationalization. Opportunities
increase for improving the performance of a firm by
introducing more up-to-date technology for handling
operation. Also, adopting a policy of
standardization allows coordination of different
activities in the various steps of the value-added
chain.

* Economies of Scale. Economies of scale can affect
nearly every function, and many technological
factors combine to produce the downward trend of the
cost-curve as volume increases. The dominant factors
are:

- Improved technological processes for high volume
production;

- The resources that can be profitability used
together only in large operations;

- The possibility of integrating manufacturing
processes for the various business activities
of very large firms operating in stable
environments;

- The sharing of resources, mainly those managed
at the corporate level, that is possible for
diversified firms with businesses in related
product markets.

* Organizational "tune-up,". A subtle result of
experience is the "tune-up" achieved by
the organization after a long history of
production, which is reflected in technological
know-how and well developed formal systems that
provide guidelines for smooth relationships among
individuals responsible for different tasks in
the production process.

The learning curve concept is useful for a variety of
managerial decisions, particularly in turn pricing
decisions and production strategies. Thus, the learning
curve has significant strategies implication.